Wednesday, September 11, 2013

The Truth About Janet Yellen's Forecasting Record

There is a myth perpetrated by supporters of Janet Yellen that she is a wiz at economic forecasting. Joseph Stiglitz wrote in NYT:

Ms. Yellen has shown herself to be not only excellent in forecasting but balanced.

However, an examination of her speeches shows that she never saw the financial crisis coming, even as the housing market was collapsing. She did not indicate serious concern about the economy until 2008, even though the housing market was collapsing a full year before that. Here's the chart that shows the collapse of the housing market starting in 2007.

Here are Yellen's remarks during 2007.

January 22, 2007 at a speech to the Joint Rotary Clubs of Reno and the East Bay (SF Bay Area)
Reno, Nevada, Yellen said:

While the decline in housing activity has been significant and will probably continue for a while longer, I think the concerns we used to hear about the possibility of a devastating collapse—one that might be big enough to cause a recession in the U.S. economy—have been largely allayed

On February 23, 2007 during a speech at Sacramento State University’s College of Business Administration Executive Speaker Series, Co-hosted with the Chartered Financial Analysts Society of Sacramento, she said:

Despite the continued weakness in housing construction, which as I said enters directly into the calculation of real GDP, there are some signs of stabilization in other aspects of housing markets, suggesting that construction activity may level out before too long. For example, home sales have steadied somewhat after falling sharply for a year or so. Considering this in combination with the continued drop in housing starts that I mentioned earlier, it is not surprising to find that inventories of unsold homes have begun to shrink. This development suggests that the process of resolving the imbalances between demand and supply in the housing market may be underway, and, as a result, we could very well see the drag on real GDP from housing construction wane later this year.[...]The bottom line for housing is that the concerns we used to hear about the possibility of a devastating collapse—one that might be big enough to cause a recession in the U.S. economy—while not fully allayed have diminished. Moreover, while the future for housing activity remains uncertain, I think there is a reasonable chance that housing is in the process of stabilizing, which would mean that it would put a considerably smaller drag on the economy going forward.

She also said during that speech:

Outside of housing and domestic autos, the rest of the economy has been doing quite well; that’s why it might be called a “bi-modal” economy.

In other words, it looks as if the economy is pretty close to the “glide path” I mentioned before—since the first quarter of last year, growth has slowed to a bit below most estimates of the economy’s long-run potential, and more recently the risk of an outright downturn has receded along with the early signs of stabilization of housing markets.

In summary, I believe that a soft landing is the most likely outcome over the next year or two.

July 12, 2007, during a speech to a Community Leaders Luncheon
Anchorage, Alaska, she said:

So I suspect that the markets and the Committee have become more closely aligned, sharing the view that growth in the U.S. is, and is likely to remain, healthy. In further support of this view, stock market values have risen and implied volatilities have been flat or trended down, as we continue to get stronger news on overall economic growth. Moreover, these developments—robust economic data, rising long-term rates, higher expected policy paths and climbing stock market indexes—are global phenomena, occurring in many industrialized countries.

The bottom line for housing from a national perspective is that it has had a significant depressing effect on real GDP growth over the past year. While I wouldn’t want to bet on a sizable upswing, I also wouldn’t be surprised to see it begin to stabilize late this year or next.

December 3, 2007, during a speech to the Seattle Community Development Roundtable and the Seattle Chamber of Commerce Board of Trustees Seattle, Washington, she said:

To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level.

Yellen never saw the crisis coming. She only turned negative on the economy in 2008. It was hard to miss at that point. Early in 2008, in March, the Federal Reserve Bank of New York provided an emergency loan to JPMorgan, which used the funds to acquire the collapsing Bear Stearns. The stock market fell pretty much all year.

Yellen was more of a play-by-play broadcaster of what was in front of her rather than a great forecaster. As a forecaster, she didn't have a clue, Indeed, even as data showed weakness in early 2008, Yellen played it both ways. On February 12, 2008, in a speech before the San Francisco Planning and Urban Research Group, she did offer warnings about the economy but also hedged by seeming to suggest the poor economic performance might only be a problem in the first half of 2008:

Current indicators point to continued anemic growth for at least the first half of this year as well as significant downside risks even to those weak expectations.

2 comments:

"First, if the bubble were to collapse on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?

"My answers to these questions in the shortest possible form are, “no,” “no,” and “no.”"

-- Janet Yellen, 9/27/2005 (She goes on to argue against a "tighter policy", which is to say that the Fed should continue doing more of what caused the housing bubble)

It is true that the economy can withstand the popping of a bubbleBut in the case of the housing bubble, the entire banking system was dependent on the inflated mortgages staying above water. And then the big suckers like AIG bought tons of credit default swaps on margin. Anyone with a lick of common sense could see the risks escalating. Maybe it was a case of all these political sycophants not being able to openly say that it was a house of cards, for fear of triggering an event. The only people who were able to make the call and declare that the emporer had no clothes were Wall St outsiders and wild eyed speculators. Goldman Sachs saw it coming, but kept their positions under wraps so they could find more suckers to take the opposite side of the trade. Nothing has really changed on Wall St, and Yellen is a bone thrown to the Street to keep the liquidity bubble intact.